The central bank announced a 300bp increase in the late liquidity window interest rate to 16.5%, from 13.5%, all other policy instruments were kept unchanged. This announcement may help to stabilise the currency in the very short term, but it is highly unlikely to herald the beginning of phase of renewed currency stability beyond few months. In this report we highlight all the critical economic developments that in our view will influence the performance of Turkish assets in the coming 18 months.
Our simple real GDP model signals that a fairly sharp slowdown could materialise in Q2 and Q3 of this year, re-accelerating thereafter. There are two equally important considerations to make on Turkey’s growth prospects: business cycle fluctuations and the trend growth, which Turkey has managed to keep stable at a high 5% in real terms in almost twenty years. In terms of the business cycle, we believe a lot of debt has been accumulated in the financial and non-financial corporate sectors, which sooner or later will force a period (2-3 years) of balance sheet restructuring and low investment (and thus shorter spell of real GDP growth at or below zero). However, a major slowdown (similar to the 2009 episode) does not appear realistic until domestic challenges escalate (such as severe political uncertainty coupled with balance sheet difficulties) and a major global slowdown materialises. We take the view that the European business cycle has past the peak but the US hasn’t yet and, most importantly, the big central banks remain painfully dovish, preventing the business cycle downswing to materialise as it would do “normally”. So, Turkish growth may well defy expectations once again thanks to a decent global demand and the benefits of a weaker currency. That said, when the global downturn does come, Turkey trend real GDP growth will likely fall from the current high of 5% for at least 2-3 years.
We expect to see a pick-up of inflation as a result of the depreciation, but not a massive jump as the inflationary effect of a weak lira in our view will be offset by a likely slackening of the labour market and intensified competition in various sectors in response to the slowdown in demand.
Real interest rates measured as the policy rate minus current inflation do not seem out of line with the last few years and actually in line with real trend growth, something that is unusual in Europe these days. The real policy rate is zero or negative in most countries in central Europe and the eurozone. In a world that is still heavily influenced by very low interest rates from central banks and non-resident investors’ positioning is fairly light, a sizeable positive real interest rate could re-start the capital inflows temporarily, especially if the June 24th elections were to deliver an outcome that secures prudent macroeconomic management.